Tag Archives: quarterly letter

 

This quarter, on May 26, the Dow Jones Industrial Average turned 125 years old. The index of 12 industrial companies closed that first day of trading, May 26, 1896 at 40.94. Since that day, the Dow has certainly evolved with the U.S. economy through the Great Depression, two world wars and other events, such as the terrorist attack of 9/11, that have embodied the 20th and early 21st centuries.

The Dow has risen an average of 7.69% per year since 1896 according to historical data from the Wall Street Journal. This is a simple arithmetic average and investors’ actual returns could have been quite different (considering the full range of annual changes over the past 105 years of -52.67% in 1931 to a high of 66.69% in 1933). It first climbed above 100 in 1906, topped 1,000 in 1972 and crossed 10,000 in 1999. When Frank started his investment career in 1981, the Dow was around 933. Bill started in 1986 and the Dow was around 1,700. To think that now the Dow is trading around 34,000 is somewhat remarkable, but is a worthy reminder of the power of compounding and the benefits of staying invested through thick and thin.

Charles Dow, who was the first editor of the Wall Street Journal and Edward Jones, created the industrial, smokestackfocused gauge to help explain stock market movements to the Journal readers. The roster of companies in the Index expanded to 20 from 12 in 1916, and to 30 companies (where it stands today) in 1928. Procter and Gamble, which was added in 1932, is the longest running member of the Index since General Electric departed the Index in 2018. Well-known stocks that have come and gone over the years include Studebaker, Sears, Woolworth, and Kodak. Newcomers now give the Dow more of a “non-industrial flavor” with the likes of Salesforce.com, Amgen and Apple.

The Dow Jones Industrial Average will always remain the bellwether measurement indicator when someone asks, “What did the market do today?” Other pertinent indexes such as the S&P 500 and NASDAQ are quite relevant as important measurements as well. A lot of “how the market did today” is determined by how United Healthcare, Goldman Sachs, Home Depot and Microsoft do because the Dow is a dollar-price weighted index, meaning the higher the constituent’s share price is, the more influence that stock has on the Index that day. Walgreens, Cisco Systems, Coke, and Verizon need large moves in their daily prices to move the index due to their lower share prices relative to the larger firms.

Happy 125th birthday to the Dow Jones Industrial Average!

Market Statistics as of June 30, 2021

Index	2021 2nd Qtr	2021 YTD 6 Months
DJIA	5.08%	13.79%
S&P 500	8.55%	15.25%
S&P 500 (equal weight)	6.90%	19.18%
S&P Mid Cap	3.64%	17.59%
Russell 1000/Growth	11.93%	12.99%
Russell 1000/Value	5.21%	17.05%
Russell 2000	4.29%	17.54%
NASDAQ Comp.	9.68%	12.92%

The S&P 500 Index closed the first half of the year at a record high, gaining 15.2% on a total return basis. The first half return was the best in over twenty-two years and represented the fifth consecutive quarter of gains. Stocks were the only asset class with positive returns in the first half as treasury bonds (-7.5%), investment-grade bonds (-1.1%) and gold (-6.8%) all fell. International stocks (MSCI-ACWI-ex US) and emerging markets trailed U.S. stocks gaining 9.4%, and 7.6%, in U.S. dollar terms, respectively. For the first half of 2021, the Russell 1000 Value Index led the Russell 1000 Growth Index by 4.05%, despite the strong outperformance by growth in June of over 740 basis points. For the first half, all eleven of the major S&P 500 sectors posted positive returns. Energy was the standout sector, gaining 42.3%, followed by financials (+24.5%), real estate (+21.7%) and communication services (+19.1%). Market laggards were consumer staples (+3.6%) and utilities (+.79%). Small-cap stocks and mid-cap stocks outpaced the larger companies in the first half despite lagging in the second quarter. As the quarter ended, investors began to weigh whether the recent acceleration in inflation is transitory or the beginning of a longer-term trend that might force the Federal Reserve to become more hawkish.

Commentary & Thoughts

Last quarter’s letter discussed our framework of investing in growing companies at reasonable prices. We wrote about what we believed to be unreasonable prices being paid for some growth stocks and unproven entities such as SPAC’S and Software (SaaS) stocks. We also referenced some simple valuation math around similar growth stocks from the late 1990s. The tide has seemingly started to recede as the heady valuations of many growth stocks have started coming back to earth since the end of the first quarter. Some of the market darlings of the beginning of the year, such as Tesla, Shopify and the meme stocks have entered correction territory, somewhat related to what is referred to as “re-opening” trades as there has been some rotation to pro-cyclical companies that should benefit from the re-opening of the economy as the vaccines take hold. Covid-winners, like digital transformation and secular growth stocks, have underperformed.

Speaking of the speculative trading frenzy in the meme stocks, such as AMC Entertainment, one has to be taken back by the quote at the beginning of this letter. We can’t recall such a pointed warning in a prospectus before.

As the U.S. economy normalizes further, we expect solid earnings growth from many companies that were negatively affected during the pandemic period. Future earnings growth for these businesses should be quite good, while virus benefactors, Zoom, Peloton and food delivery companies may suffer somewhat.

Long-time readers of our content appreciate our discipline around prices we pay when investing your capital. We have referenced many times that interest rates have trended down from 14% to 0% for the past 40 years. Doubting that they go negative and considering the high probability interest rates normalize to the ranges seen in the early 2000s (4%-10 year Treasury), P/E multiples should contract. We hopefully are positioned in reasonably priced growing businesses where the earnings growth should overcome most of the valuation compression

Second Quarter Portfolio Activity

We again made no changes to our model portfolio. Trading activity was again light and only involved trimming our position in FedEx and adding slightly to AON in a few accounts. The quarter was busy as usual on the research front as we participated in meetings with management from Raytheon and UPS. We also spent time with our friends from long-time investee Brookfield Asset Management learning about a new private equity fund we are interested in. Connor spent the day with the investment team at Markel as they, along with an investment colleague in New York, hosted an informative virtual conference highlighting some new ideas.

Selling is not easy

After a very successful run in FedEx, we opted to trim back the size of our position. Normally, with a good growing business, we don’t like to trim. However, given the circumstances around FedEx’s valuation, as well as the position size in many accounts, we elected (after much handwringing) to trim back the position.

As often said, the hardest decision in investing is deciding when to sell. In the GARP Focused Opportunity strategy, we find selling or trimming difficult. Researching companies, buying, holding, and selling are all tough with all of the dynamics to consider. With selling, there are unique considerations such as the amount of capital gain you incur, opportunity cost and, Charlie Munger’s dogma of never interrupting compounding unnecessarily. We are also reminded of the quote from the great Peter Lynch, “Selling your winners and holding your losers is like cutting the flowers and watering the weeds.”

When we sell or trim, it can create a variety of potential outcomes, such as, the security we sold continues higher while what we allocated your proceeds to declines. Fortunately, we do not feel compelled to immediately reinvest sale proceeds if there is nothing of intelligent value to buy. If we “top tick our sale (trim at what we think might be the highest point in the cycle and the stock declines afterward), we might find ourselves thinking we are smarter than we actually are and could lead us to lose some of the humility needed to be a successful investor.

Trimming position sizes in portfolios can be a prudent exercise in portfolio and risk management, but selling a model position outright (which we haven’t done in quite a while) typically occurs in the event of four possible scenarios:

1. Our thesis regarding the investment has changed.
2. The valuation (stock price) gets very overvalued relative to business fundamentals.
3. Significant management change or poor capital allocation skill is diminishing shareholders’ value.
4. We find a company that is superior to the one we are selling.

Our turnover is typically quite low, approximately 20 to 25%. We have positions in companies that we have owned for many years. We do extensive research on a business and the majority of the time, we get the thesis fairly correct. This leads to longterm ownership.

Phil Fisher, the legendary investor and author of “Common Stocks and Uncommon Profits” had a list of 15 points to be considered when evaluating an investment. He was relentless in adherence to these 15 qualities and felt if he checked all boxes, he would rarely need to ever sell. But mistakes of judgment do happen and it is mostly the price paid at the time, but sometimes the thesis. Fisher writes: “When a mistake has been made in the original purchase and it becomes increasingly clear that the factual background of the particular company is, by a significant margin, less favorable than originally believed… then the proper handling of this type of situation is largely a matter of emotional self-control. To some degree, it also depends upon the investor’s ability to be honest with himself.”

In the case with FedEx, we obviously understand the company well and feel like we know the key fundamentals of the delivery business, including UPS. Our first purchase in 2019 proved to be a little early. But who knew a global pandemic would arrive and dramatically alter all stock prices and yet, enhance the delivery business as brick-and-mortar traditional retail moved online and needed to be delivered? We always knew FedEx was a capital-intensive business given the thousands of planes and trucks they operate, not to mention the massive logistical labyrinth the company faces daily. We never liked the capital allocation to the TNT Express acquisition in Europe and watched as FedEx wrote down our shareholder value for more quarters than we would like to admit. What we did do well was buy a lot more shares at a really good price during the virus selloff of last year. That second purchase has proven to be almost a triple, and coupled with our original purchase, a wonderful return. From a risk management perspective, given the position size in many accounts coupled with the valuation, we painstakingly elected to cut the size back to a normal weight.

Hopefully, Peter Lynch would approve. We cut a few flowers and put them in a vase to enjoy while leaving the garden intact
with little weeding needed.

Contributors and Detractors for Focused Opportunity Growth

Our thoughts on positions that had the most positive impact on the strategy for the period ending 6/30/2021

Danaher (DHR) +19.2%
Danaher’s momentum continues with another quarter of strong top-line revenue and bottom-line profit. Strength in its life sciences and medical diagnostics segments were related to tailwinds from COVID-19 effects. The Danaher business system remains focused on accelerating core growth and margin expansion through innovation.

Charter Communications (CHTR) +18.6%
Charter continues to enjoy its strong competitive position as a leader in delivering high-speed broadband and video. Charter’s cable network has significant competitive advantages versus its primary competitors, telephone companies AT&T and Verizon. Free cash flow this past quarter was $1.9B, up from $1.4B a year ago despite higher capital spending.

Moody’s Corporation (MCO) +18.3%
Moody’s is coming off of its biggest quarter ever with revenue of $1.6B. This strength was driven by higher ratings revenue as new bonds came to market in the leveraged loan arena needing to be rated. Moody’s continues to operate very profitably in its cozy duopoly with S&P. Moody’s is one of our more fully valued (expensive) businesses but offers a strong competitive position.

Alphabet, Inc (GOOG) +17.2%
Google had blowout quarterly earnings on the back of its accelerating core search business and rapid growth in YouTube, Google Cloud and Google Play. We remain solidly invested in Google and we are particularly pleased with the efforts and success the company is having by gaining a stronger foothold in the fast-growing public cloud market.

Wells Fargo (WFC) +14.3%
Wells Fargo continues its turnaround and healing from its reputational damage. We remain optimistic about the potential earnings power over the next several years. This next quarter, we expect to see the regulatory-driven asset cap lifted thereby driving much desired and accretive capital reallocation, especially buybacks.

Our thoughts on portfolio positions that had negative or the least positive impact on the strategy for the period ending 6/30/2021

Dollar Tree (DLTR) -14.2%
Dollar Tree Plus (its new format that includes a section with discretionary items that cost more than the traditional $1 Dollar Tree limit) and its combo stores of Family Dollar and Dollar Tree continue to resonate with customers, driving growth. Headwinds, due to shipping and freight costs (due to shortages) have impacted the shares recently. We believe consumer’s desire for convenience and value continues to position the company for future growth.

Walt Disney (DIS) -7.0%
Disney’s impressive content lineup – including Disney, Pixar, Marvel, Star Wars, ABC, ESPN and acquired FOX content – has enabled the company to be a leader in streaming video. Disney management claims to be on track for over 300 million paid streaming subscribers by 2024. By contrast, Netflix has about 208 million today. We remain very comfortable long-term investors in Disney, notwithstanding its premium valuation.

Verizon (VRZ) -3.9%
Verizon remains well positioned as the wireless leader in network quality and reliability. The company’s large loyal customer base is one of its key investment merits. As 5G becomes a reality in the years ahead, we will pay more for that experience and Verizon should profit. Verizon remains more profitable than its competition due to its efficiency and large market share. We remain long-term investors as long as we stay wedded to our phones.

Abbott Labs (ABT) -2.5%
Abbott is taking a breather as much welcomed relief from the vaccines has impacted Abbott’s COVID-19 diagnostic testing machines. Profitability continues to shine in other areas of the company’s business, such as nutritionals and established pharmaceuticals. We like our future growth prospects as Abbott is investing in heart products such as replacement valves. With 60% of sales occurring outside the U.S., we look for long-term growth continuing.

Mastercard (MA) -0.5%
In our opinion, few companies can match Mastercard’s record of consistent, rapid revenue and earnings growth. Mastercard benefits as consumers reemerge from the pandemic and are spending more on credit, debit and prepaid cards. The company continues to adapt to new trends (including threats), such as mobile payments and virtual cards, while pursuing large new opportunities such as business-to-business transactions. Mastercard is another one of our more expensive stocks.

Commentary & Thoughts

As markets rise, it is human nature for investors to become more optimistic. As Warren Buffett once stated, it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.” In reality, the emotions of fear and greed make this more difficult than it might seem for many market participants. A recent survey done by Natixis Investment Managers (6/23/2021), showed that individual investors expect the U. S. markets to increase by 17.3% this year, after inflation. This is on top of a return of 40.8% for the S&P 500 Index over the past twelve months. It is also more than twice the return on U. S. stocks since 1926, which when simply averaged, approximated 7.1% (after inflation) for the entire period.

The CFO Survey, compiled by Duke University and the Federal Reserve Banks of Richmond and Atlanta, found in March 2021 that chief financial officers expect the S&P 500 to return 8.4% annualized over the next decade, up from the 6.8% they predicted back in December 2020. While corporate CFO’s have become more optimistic, it appears less so than expected by individual investors. Clearly, emotions have shifted from “fear,” which was evident as the pandemic began in the first quarter of 2020, to what is likely to be excessive “optimism” today. As the chart below indicates, the S&P 500 trades at 21.5 times forward earnings estimates versus a 25-year average of 16.7 times. The S&P 500 Index dividend yield is 1.44%, well below the 25-year average of 2.02%. Historically, when the markets trade at elevated valuation levels, return expectations would be more muted going forward. Perhaps individual investors need to reign in their optimism.

S&P 500 Index

Valuation Metric	Latest	25-Year Average
Forward P/E	21.5x	16.7x
Dividend Yield	1.44%	2.02%
Price/Book	4.19x	3.02x
PPrice/Free Cash Flow	16.1x	10.9x

While valuation levels in the market appear elevated on a historical basis, “value” continues to look extremely compelling relative to “growth”. The chart below from J. P. Morgan Asset Management compares the relative forward price/earnings ratio of the Russell 1000 Growth Index to the Russell 1000 Value Index.

Valuation Metric	Russell 1000 Growth	Russell 1000 Value
Price/Book	14.0x	2.7x
Dividend Yield	.7%	1.9%
Price/Earnings (ex neg earnings)	38.1x	19.5x

In recent weeks, investors have shifted back to growth strategies, making the case for value (in our opinion) even more compelling. We often remind investors that we think a great company does not always result in a great stock. The price one pays for a security is an integral part of the return the investor ultimately receives. As Benjamin Graham stated, “The margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price, nonexistent at some still higher price.”

Second Quarter Portfolio Activity

During the most recent quarter, there were no new portfolio additions or deletions. We did trim positions in UPS, Invesco and Charles Schwab during the quarter as position sizes became outsized due to strong performance in recent quarters. We remain constructive on each company, but felt on a short-term basis, the shares had met our price objective.

Contributors and Detractors for Classic Value

Our thoughts on positions that had the most positive impact on the strategy for the period ending 6/30/2021

United Parcel Service (UPS) +21.4%
UPS is the world’s largest express carrier and package delivery company. UPS’s earnings momentum continued in the most recent quarter with domestic average daily volume growing by 12.8% to 20.4 million packages per day. Under the leadership of new CEO Carol Tome, we expect UPS to be successful in removing $500 million in nonoperating expenses over the next several years.

Roche Holding (RHHBY) +15.3%
During the most recent quarter, sales of COVID-19 tests helped to offset weakness in the drug business, as the pandemic limited doctor visits for other diseases. Recent strength in the share price is likely due to rumors that Roche will seek early FDA approval for Alzheimer’s disease candidate Gantenerumab.

Alphabet (GOOGL) +14.7%
Alphabet’s first quarter revenues surged 34% largely due to increased advertising spending by its customers. We believe GOOGL remains attractive and trades at a discount to the “sum of the parts”, which Sanford Bernstein estimates could be as high as $3,100 per share. Alphabet has a rock-solid balance sheet with $137 billion in cash, versus $14 billion in long-term debt.

Diageo (DEO) +14.5%
Diageo is a London based spirits company with popular brands such as Johnnie Walker, Bailey’s, Captain Morgan, Crown Royal, Smirnoff and Guiness Beer. In an update on May 12th, the company stated they saw strong growth across all regions. While DEO shares are no longer priced cheaply like they were in the pandemic, the company has a unique competitive position “moat” that in our opinion, could not be easily duplicated.

CVS Health (CVS) +12.3%
In the past quarter, CVS reported results that were ahead of analysts’ forecasts. CVS shares currently trade at approximately 10 times forward earnings while the S&P 500 trades at 21 times. CVS shares yield 2.4% versus 1.4% for the S&P 500. Despite the recent move, we believe CVS shares represent good value.

Our thoughts on portfolio positions that had negative or the least positive impact on the strategy for the period ending 6/30/2021

Dollar Tree (DLTR) -14.2%
Despite reporting earnings that were in line with expectations, Dollar Tree shares have been weak as fears of cost pressures (labor and freight costs) have weighed on the stock. The new concept that combines Dollar Tree and Family Dollar brands has been promising and are expected to drive a same-store sales lift. Long-term debt, which peaked at $7.3 billion at the time of the Family Dollar acquisition has been pared to $3.2 billion and should continue lower. Dollar Tree shares trade at approximately 16 times earnings versus 20 times for competitor Dollar General. We think the shares remain attractive for investors.

Intel (INTC) -13.0%
Intel’s appointment of Pat Gelsinger as CEO in February was initially met with enthusiasm, however to us, the honeymoon period appears to now be officially over. Intel’s earnings will likely decline over the near term, however, Gelsinger has exciting plans to “redouble on manufacturing” so that Intel regains its competitive edge. Intel shares appear attractive as they trade at only 11 times earnings (versus 38 times earnings for the SOXX semiconductor index) and yield 2.5%.

Fiserv (FISV) -12.5%
Fiserv provides internet banking, bill payment credit card processing and risk management to 18,000 financial institutions. Fiserv’s first quarter earnings exceeded analysts’ expectations while revenues were slightly behind projected numbers. The company benefited from good organic growth, particularly subsidiary Clover, whose revenues were up 36%. Growing cash flows should allow for deleveraging following the purchase of First Data in 2019.

Sony (SONY) -9.0%
In the most recent quarter, Sony reported a record net profit, with earnings largely driven by the Playstation division. The recent report was cautious going forward due to projected declines in music and games. Sony’s finances are strong with cash and equivalents standing at over $41 billion, while debt only represents 17% of total capital. In our opinion, Sony has excellent long-term prospects with dominant positions in gaming, music, pictures and semiconductors.

Walt Disney (DIS) -7.0%
Disney is well positioned for a near-term rebound as the theme park business recovers from the Covid 19 shutdown. The shares’ recent pullback has largely been attributed to the fact that Disney+ signed on less than expected new users in the most recent quarter. Keep in mind Disney+, at quarter end, had 104 million subscribers which is incredible over an eighteen-month period.

Commentary & Thoughts

U.S. developed markets continue to outperform this quarter relative to the rest of the world, especially Asia. We remain cognizant of strained U.S. and China relations. We believe the incentives for the Chinese government to promote economic growth remain strong. We are closely watching globalization in general as the movement of goods and services around the world has been called into question with the pandemic. Global low-cost logistics have been deflationary in the past. If large chunks of U.S. production in Asia move back to the U.S., Canada and Mexico to better endure more trustworthy supply chains, the ramifications could be more inflationary

We receive occasional questions from clients regarding our positions in Chinese stocks. We wouldn’t claim to fully appreciate all the Chinese geopolitical risks that are apparent, but we are comfortable with what we own, notwithstanding the weakness this quarter.

Our comfort comes from Bloomberg data that reports that Asia accounts for 60% of the world’s population and is forecasted to contribute 60% of the world’s economic growth over the next decade, in large part because 90% of 2.4 billion estimated new members of the middle class are from Asia. According to Bloomberg, Asia’s share of global GDP was around one third in 2000, reached 40% in 2020 and is forecast to be 50% by 2040.

China is the driving force in Asia. Its economy continues to evolve from an export-driven focus to more of a consumer led one. The wealth creation in China has been remarkable and we believe it should continue to materially outpace the rest of the world on that measure.

Export-driven Europe stands to benefit from calmer foreign trade policies. Brexit for now “is what it is” and the end of this uncertainty could unlock some real investment into European supply chains. Europe could possibly be more of a coiled spring than many expect and with pent-up demand, consumer resilience, and increased savings now in the forefront, there could be several years of robust growth ahead. Pre-pandemic, Europe was a market that was ripe for special situations such as activism, M&A, breakups and spinoffs. One of our key portfolio positions, Vivendi, announced just this sort of thing with its pending spinoff of Universal Music Group. We believe this should unlock significant shareholder value.

Live Oak Private Wealth International Portfolio Activity

We made no model changes to the International strategy. The only portfolio activity was buying and taking New Oriental Education to a full model weight position in all global model accounts.

We keep doubling down on our research efforts, making sure we appreciate the risks New Oriental Education faces as the Chinese government is implementing additional regulations on online education companies, which has heightened the uncertainty and weighed tremendously on the stock price. The Chinese are extremely focused on education and the acceptance rates to the top schools in China are much lower than the rates at comparable schools in the U.S. New Oriental’s primary business is after-school tutoring, preparing students for the extremely rigorous high school and college entrance exams. The stock has pulled back a lot more than we expected as any and all growth has been called into question and there is a tremendous amount of uncertainty. We feel like this has created an opportunity for patient investors like us. The P/E multiple was too high going into this uncertainty with heightened government regulations. If you subtract the net cash on the balance sheet from the current market cap, EDU trades for 15x our earnings estimate for next year. Founder, Michael Yu is the largest shareholder with an 11.5% stake worth $1.4B, down from over $3.0B. He has been an excellent steward of the company’s capital in the past and hopefully, he can help to navigate us through this temporarily uncertain time, which has created this opportunity.

Contributors and Detractors for International Strategy

Our thoughts on positions that had the most positive impact on the strategy for the period ending 6/30/2021

Heineken (HEINY) +16.7%
Heineken continues to build back business that was lost due to the pandemic shutdown. Europe has been a little slower to open up, but bars and restaurants are coming to life and from our perspective, Heineken’s namesake brand is well positioned to gain market share. We remain content investors as the company is not letting a crisis go to waste by planning on $2B euro-cost containment endeavors to expand margins further. Heineken is the world’s second-largest brewer.

Roche Holdings (RHHBY) +15.3%
Roche’s drug portfolio and industry-leading diagnostics continue to strengthen the company’s competitive advantages. The Swiss healthcare giant is in a unique position to guide global health care to a safer, more personalized and more cost-effective endeavor. Blockbuster cancer biologics, Avastin, Rituxan and Herceptin are big revenue drivers. The company’s U.S. arm, Genetech, has solid important therapies in oncology. We like the long-term prospects for Roche.

GVC Holdings (GVC) +13.6%
GVC, now known as Entain, is an international sports betting and gambling company. The company’s gaming operators operate through both online and retail channels. The company is growing rapidly through M&A and organic growth emanating from tremendous demand for sports betting as many U.S. states move to legalize sports wagering. We believe Entain’s new collaborative venture with BetMGM will most likely unlock significant growth opportunities.

Phillip Morris International (PM) +12.6%
Phillip Morris continues to innovate and develop reduced risk cigarette products. The company is purposedly disrupting its own legacy combustible cigarette business with its new IQOS product. This “heat not burn” cigarette uses a technology-enhanced device that positions Phillip Morris as a first mover in heated tobacco. With 28% global market share and over a 4% dividend yield, we are comfortable investors.

Ferguson (FERG) +12.3%
As the world’s leading distributor of plumbing and heating products, Ferguson is benefitting from tremendous growth due to new housing construction and pandemic stay-at-home renovation projects. U.S. market demand continues to accelerate as the U.S. economy fully reopens. Recent quarterly revenue of $5B was a 24% increase over last year. As more and more new households are formed and housing remains robust, we are bullish on Ferguson.

Our thoughts on portfolio positions that had negative or the least positive impact on the strategy for the period ending 6/30/2021

New Oriental Trading (EDU) -43.5%
New Oriental’s stock price continues to be very weak in the face of significant new regulations placed on Chinese online education companies. There is tremendous uncertainty weighing on this sector and selling pressure hasn’t abated. As long-term investors, we are sticking with New Oriental as we feel that they are the market leader in this educational niche and therefore, can endure this uncertain period and respond to the government’s new protocols.

GAN LTD (GAN) -15.1%
GAN is an award-winning provider of enterprise Software-as-a-Service (SaaS) solution for online casino gambling, commonly referenced to as iGaming, and online sports betting. Online sports betting is a rapidly growing industry as many U.S. states legalize sports wagering. GAN offers an internet gaming ecosystem platform that is helping the brick-and-mortar casino industry transform to digital. GAN is our smallest company in our portfolio with annual revenues of $110mm. Potential rapid growth lies ahead and we are opportunistic about the company’s growth prospects.

Ten Cent Holdings (TCEHY) -10.2%
Ten Cent Holdings’ WeChat application is the dominant messaging platform in China. The company continues to use this dominance to position itself in many new growth areas such as payments, video and music streaming, and online advertising. Tencent is also the leader globally in video games. The stock, like most of the Chinese stocks this quarter, was weighed down by new, unpredicted regulations emanating from the Chinese government. We remain comfortable with the company’s future growth prospects.

Daikin Industries (DKILY) -8.9%
Daikin is a large Japanese conglomerate. Our stock thesis resides with Daikin North America, which is a global leader in HVAC applications. The company’s commitment to air filtration and elevating the quality of air in homes, businesses and public spaces gives us comfort in growth ahead. Now post-pandemic, all of us are laser-focused on virus-free clean air and Daikin is positioned to address this need. New subscription-based programs for monthly air filter replacements bode well for the company’s affiliate, American Air Filter Company in Louisville, KY.

Baidu.com (BIDU) -7.2%
Baidu is the Google of China. Founded as a search engine platform, Baidu is now a leading artificial intelligence company with a strong internet foundation. Baidu provides a large suite of online marketing services which continue to grow handsomely. Like many of our other Chinese tech companies, Baidu has been weighed down by heightened concerns of increased regulations by the Chinese government. Over time, we feel this uncertainty will abate and the shares will respond favorably to the business growth that hasn’t slowed.

Our team spends a lot of time honing our processes to improve our decision-making and hopefully your outcomes. One of our endeavors is studying and researching different frameworks that can position us to make better decisions. Frameworks need to adapt and evolve so that in building and managing investment portfolios, we actually see the great opportunities when they come along. The key to our framework is deep thought or mindfulness. We try to have eyes wide open and awake and be aware of the changing environment around us. Purposely being mindful crafts better behavior and decisions that set us up for better investment results.

Mindfulness is not brain surgery, it is just the disciplined act of paying closer attention. It sounds so simple, but it is difficult in today’s distracted world. The brain is wired to work against us in today’s modern environment of mobile phone notifications, texts, email and open offices, etc.

Time is an important element in mindful decision-making. If we don’t structure quiet focus time for research, opportunities will pass us by. We attempt to allocate our time for careful study with the same consciousness as we allocate the hard-earned capital you have entrusted to us. We try hard to not let our brains be bombarded with noisy information emanating from CNBC and Twitter or constant email, texts and unnecessary meetings. We strive to create time and space to find signals increasingly buried in the information deluge around us daily to make mindful, and hopefully profitable, decisions. We look at our portfolios constantly and ask what is unlikely to change over the next decade or longer and then position all of us in those best opportunities. Careful attention and concentration allow us the free time and space to connect dots when opportunities present themselves. We perceive this framework as one of Live Oak Private Wealth’s competitive advantages.

Thanks to you, our clients, Live Oak Private Wealth continues to grow. We always felt that our unique value proposition was a winner and would resonate with clients. We couldn’t be happier as we close in on September 1st, our three-year mark. To leverage our growth and future success, we are excited to share with you two new members of Live Oak Private Wealth. Laura Tayloe joined the team the 1st of May and Angel Bolton will start the 1st of August.

Laura Tayloe joins the Live Oak family as our client experience specialist. Her role will be to ensure all of our team is delivering and executing on the best possible experience you as a client receives and deserve. Laura joins us from Mainstone Capital Management in Boston and Windhorse Capital Management, a multifamily office in Boston as well as The Carlyle Group.

Angel Bolton, CFP®, joins the Live Oak family as our second fiduciary planner. Her role will be to leverage our existing extensive suite of financial planning, trust and estate capabilities on behalf of our clients. Angel joins us from the private bank division of Wells Fargo and will initially work closely with the Rocky Mount team helping them solve the many trust, tax and estate planning needs today.

Live Oak Private Wealth has been blessed from its beginning to have a solid core of very valuable service specialists, Missy Musser and Amy Bennett. Strengthening us further was the addition of Jan Robbilard and Terry Sapp, who were instrumental in Jolley Asset Managements success. Now we are very fortunate to be able to have two new qualified, delightful and professional ladies join our team. We encourage you to reach out to each of them and say hi.

Bill and the Wilmington team would also like to point out that June 30, 2021 marks an important milestone. Frank Jolley and his Rocky Mount team built a highly regarded, trusted and successful investment firm in Jolley Asset Management over 20 years ago. As Jolley Asset Management and Live Oak Private Wealth join together, Jolley’s legacy of trust, integrity, service to the client and stellar investment results lives on. The commitment to be a true fiduciary, acting daily to always do what is in the client’s best interest, lives on. So, while the name on the door in Rocky Mount might look different, what’s inside will not. Our overall value proposition has been strengthened by the addition of Frank, Bill, Terry and Jan and we couldn’t be prouder to partner with them.

“We don’t know.” This is generally our answer to the regular questions posed to us about our macroeconomic, geopolitical and market views. Whether inflation is transitory or not, when the Fed will taper and will capital gain tax hikes be retroactive are all questions we can’t answer. What we can say is that we will continue to research and hopefully find reasonably priced businesses with the hopes that they will be incremental to our portfolios.

Stocks continue their march higher, ignoring the cyclical nature of the financial markets for now. We remain very cognizant and aware of the tremendous bullish sentiment against a myriad of uncertainties. We continue to manage your wealth as we do our own, with an ample margin of safety. We are grateful and appreciative for our partnership with you and your willingness to compensate us for doing something we love to do and is so important to us all.

Our entire (and growing) Live Oak Private Wealth Team looks forward to our continued shared success together.

With warmest regards

Disclosures

1. Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown. The performance results for each equity sleeve are calculated for us by Orion Services and does not reflect investment management fees, custody and other costs or taxes. All of which would be incurred by an investor in any account managed by Live Oak Private Wealth.
2. The performance attribution represented is a simple point-to-point price percentage change for the five best and five worst portfolio positions for the third quarter ending September 30, 2020 Each equity sleeve does not and is not intended to indicate past or future performance for any account or investment strategy managed by Live Oak Private Wealth. Additionally, there is no guarantee that all portfolios will own any or all of the companies mentioned.
3. There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
4. Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
5. Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
6. The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
7. Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor. Registration does not imply a certain level of skill or training.
8. Opinion and thoughts expressed are those of Bill Coleman and Frank Jolley and not Live Oak Bank.
9. Not all portfolios will necessarily own all companies mentioned, due to factors such as legacy positions, capital gain constraints, sector concentration, time, and other considerations.

 

What a difference a year makes! In just 12 months, investors’ focus has shifted from the “fear of loss” to the “fear of missing out,” often referred to as FOMO. Let’s be honest, a year ago, nobody expected the markets to rip higher in the face of the pandemic, business shutdowns and uncertainty related to the November elections. Last year’s bear market was the shortest in history, lasting just 33 days. According to Yardeni Research, the median age of bear markets (going back to the 1920s) was 302 days. Over the years, we have discussed the dangers of market timing. To successfully time the markets, one has to be correct not only on when to exit the markets, but also must be correct on when to re-enter the markets. This is quite difficult to navigate, particularly when human emotions become involved.

In the past quarter, all 11 economic sectors showed market gains with cyclicals leading the way. Market leaders during the first quarter were energy (+29.3%), financials (+15.4%) and industrials (11.0%). Market laggards were utilities (+1.9%) technology (+1.7%) and staples (+0.5%). As can be seen in the chart below, returns for the last 12 months are staggering, led by the small and mid-cap indexes. Bonds fell in the most recent quarter as the 10-year treasury yield increased by 83 basis points, driving long-term treasury bond prices down (-13.3%) and investment-grade corporate bond prices down by (-4.5%). During the quarter, there was a large rotation from growth to value and from large caps to small caps. Additionally, the Russell 1000 Value Index outpaced the Russell 1000 Growth Index by 10.4%, the biggest rotation to value since 2001. We believe this move can be attributed to expectations of a strong earnings rebound in the more cyclical (value) areas of the markets. During the most recent quarter and year, the S&P 500 equal-weight index has outperformed the S&P 500 Index by 5.4%, and 15.7%, respectively. This represents a distinct reversal in market internals, with the average stock actually faring better than the market capitalization-based S&P 500 Index.

Market Statistics as of March 31, 2021

Index	2021 1st Quarter	Trailing 12 Months Ending March 31, 2021
DJIA	8.3%	53.8%
S&P 500	6.2%	56.4%
S&P 500 (equal weight)	11.5%	71.6%
S&P Mid Cap	13.5%	83.5%
Russell 1000/Growth	.9%	62.7%
Russell 1000/Value	11.3%	56.1%
Russell 2000	12.7%	94.8%
NASDAQ Comp.	3.0%	73.4%

As a sign of things getting better and just cause for the strength this quarter, during the first quarter, analysts increased earnings estimates for companies in the S&P 500. The Q1 bottom-up earnings per share estimate (which is an aggregation of the median Q1 estimates for all 500 companies in the index) increased by 6.0% ($39.86 from $37.61) during the quarter! This is a significant increase and is in contrast with the more typical estimate decreases. Looking at the last five years (20 quarters), the bottom-up EPS estimate has recorded an average decline of 4.2% during the quarter. Analysts have not only increased EPS estimates for the first quarter, but also the full year. The 2021 aggregation of the median estimates increased 5.0% to $175.75.1

It appears analysts were too pessimistic in their downward revisions to EPS estimates during the first half of last year. This, of course, was at the height of the virus shutdown. Late last year, analysts started raising estimates as overall economic activity started picking up. Rising commodity prices and interest rate increases appear to have played a role in the upward revision as well. Companies themselves are telegraphing more confidence as well in issuing positive EPS guidance for 2021.

Commentary & Thoughts

The internal framework surrounding our growth strategy relates to investing in growing companies at a reasonable price (GARP). We rely on checklists that are geared towards certain traits we are looking for in a successful investment. First on the checklist is the company must possess what we consider a competitive edge or structural advantage that is fueling the growth. It doesn’t have to be a rapidly growing early-stage business, but one that clearly has a runway for growth and is moving down the runway. Second is the price or value. We require a degree of cheapness in the company’s shares relative to its estimated growth. It is most important to not overestimate this growth or extrapolate it too far. Third on the list is our perception of quality. Much consideration is given to the financial health of the company’s balance sheet, the capital allocation skills and hopefully, aligned interests with management.

Growth investing has captured the majority of attention and return over the last several years, especially in many technology businesses. What we consider our reasonable price discipline keeps us out of many high-flying, popular growth companies like Tesla or the many Software as a Service (SaaS) stocks, and SPACs. Many of these very popular growth stocks have been immensely profitable to those who speculated on these shares. Why don’t we own these popular and, so far, very lucrative stocks?

Most importantly, because we are disciplined in what we pay for the expected or assumed growth in a company’s earnings. We remember the last time valuations for expected growth were priced at extreme levels, the year 2000. The math behind what you pay and what you end up getting does not work if the growth doesn’t continue exponentially. In 2000, many technology stocks were riding the dot.com wave of the internet. One such example was Sun Microsystems, which might be a worthy comparison to Tesla or the many SaaS stocks today. There is a famous quote by the CEO of Sun Microsystems, originally given to Businessweek in March 2002, just under two years after the dot.com bubble burst. This quote is now stored at Bloomberg since Businessweek was acquired by Bloomberg.

In March of 2002, after Sun Microsystems had lost about 90% of its value, Scott McNealy, Sun Microsystems CEO, said these words:

“…two years ago, we were selling at 10 times revenue when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

10 times sales is a high price to pay for any business; perhaps only justifiable in companies with really high margins and incredible growth, but stocks trading at 10 times sales is just as often an indicator of market over ebullience.

Ah…now 20 times revenues is the new 10 times revenues. Here is a small example of market darlings trading at 20 or more times trailing revenue. There are many more

Company	Market Cap	Multiple of Revenues
Tesla	$696 billion	25 x revenue
Nvidia	$332 billion	x22 revenue
Shopify	$137 billion	x54 revenue

Source – Standard and Poors

This growth end of the market is euphoric. A feature of late-stage bull markets and euphoria is the low-quality new issue market. There is a stage in the market cycle when masses of people trip over themselves to buy newly created shares at prices disconnected from reality. Wall Street salesmen will happily satisfy this demand. We have seen examples of this this quarter with low-quality new issues and there is some real garbage coming to market at dizzying valuations.

First Quarter Portfolio Activity

We made no changes to the GARP model portfolio during the first quarter. Trading activity was very light and only involved minor tweaks to a few positions. We missed our annual pilgrimage to Columbia University in New York this year for their investment conference. Fortunately, we participated virtually and came away feeling good about our portfolio positioning. We also participated virtually in the SHOOK Top Advisor Summit where we listened to many of the world’s top investment professionals debate various facets of the markets today. The balance of the quarter saw us attending many portfolio company presentations virtually and listening to a lot of conference calls.

We felt content with our portfolio based on the most recent financial updates from management, even though several of our positions are fully valued, to say the least. Clearly you will see our “growthier” positions were weaker as their higher PE multiples were compressed by the change in interest rates this quarter.

Contributors and Detractors for Focused Opportunity Growth

Our thoughts on positions that had the most positive impact on the strategy for the period ending 3/31/2021

Carmax (KMX) (+40.44%)
Carmax continues to execute well as demand for autos remains strong. We believe the recent acquisition of Edmunds.com further strengthens Carmax’s online and omnichannel experience. The company’s new “love your car” 30-day return guarantee should boost sales.

Wells Fargo (WFC) (+29.46%)

Bank of America (BAC) (+27.65%)

Charles Schwab (SCHW) (+22.89%)
All three of these financial companies benefited in the quarter mostly by PE multiple expansion due to the rise in interest rates. Wells and Bank of America both reported a release of loan loss reserves. Schwab continues to digest the TD Ameritrade acquisition. Should reflation continue as economies open up, interest rates should tick higher along with PE multiples for banks.

Fox Corp A (FOXA) (+24%)
There were no noteworthy developments with Fox during the quarter. Its stock was boosted by the rotation to more value-oriented media stocks. We are watching closely Fox’s involvement with the growth in online sports gambling.

Our thoughts on portfolio positions that had negative or the least positive impact on the strategy for the period ending 3/31/2021

Verisign (VRSN) (-8.15%)
We remain comfortable with Verisign, one of our smaller positions. Verisign puts the dot in dot.com and while the growth of new internet domain names has slowed, the resiliency of their registry business continues to be quite attractive to us, producing copious free-cash-flow.

Apple (AAPL) (-7.8%)
What can we say about Apple except that we still love the company, its capital allocation, its global brand and products. It just had an off quarter for the stock, as its PE multiple contracted due to higher interest rates and the rotation away from mega-cap tech.

Charter Communications (CHTR) (-6.73%)
Charter continues to add broadband internet customers that are acting to offset the churn in traditional cable bundle video customers. The more streaming increases and work/school from home persists, the more demand needed from Charter. A little PE contraction here too.

Visa (V) (-3.20%)
Visa, one of our more fully valued positions, continues to perform well. Reopening the world will benefit the company as spending increases, especially cross-border travel.

Verizon Communications (VRZN) (-1.02%)
Verizon continues to invest heavily in rolling out its 5G offering. Meanwhile, we remain very comfortable with this crucial utility many of us rely on and are happy with its 4%+ dividend yield. Oh, and Mr. Buffett bought $4B of its shares.

Commentary & Thoughts

A year ago, we stated that “value” looked cheap relative to “growth.” One year ago, the Russell 1000 Value Index was trading at 13.2 times earnings, 1.6 times book value and had a dividend yield of 3.2%, while the Russell 1000 Growth Index was trading at 26.2 times earnings, 6.9 times book value and yielded 1.2%. Value continues to look attractive to us with a current price/earnings ratio of 18.2 times earnings versus a price/earnings ratio of 29.2 times earnings for growth. This compares with a price/earnings ratio of 21.9x for the S&P 500 Index. Currently, the top ten names in the S&P 500 Index make up 27.4% of the index and trade at a lofty price/earnings ratio versus the rest of the index (see chart below). As the chart suggests, the top 10 names in the index remain pricey versus the rest of the market, just as growth remains expensive relative to value. Since 2012, the top names in the S&P 500 Index have been dominated by the “FAANG” tech giants (Facebook, Amazon, Apple, Netflix, and Google/Alphabet), which we think are all wonderful businesses with what appear to be dominant moats. Typically, there is turnover in the ranks of the top ten names (by market capitalization) and that is actually a sign of what should happen in a capitalist economy. In 1980, ironically seven of the top ten holdings were comprised of energy companies—today energy only makes up 2.8% of the entire index. Needless to say, it is difficult to stay on top of the index, just ask IBM (top stock in 1980 and 1990), General Electric (top stock 2000) and Exxon (top stock 2010). All of those companies have struggled mightily and produced poor returns for investors over the past three decades. We continue to believe the next few years will favor value over growth and that the average stock in the S&P 500 Index will outperform the S&P 500 Index.

P/E Ratio of top 10 vs. rest of the S&P 500 Index

	Current	Average	% of average
Top 10	30.1x	19.5x	154%
Remaining Stocks	19.6x	15.6x	126%
S & P 500	21.9x	16.2x	135%

Source: JP Morgan Asset Management (3/31/2021)

This past quarter, we have seen a number of strange events that caused fundamental investors like ourselves to just shake our heads in disbelief. Stocks are now referred to by some as “stonks,” profits are called “tendies” and “diamond hands” are participants who are willing to hold their positions through thick and thin.

A number of distressed companies, led by GameStop, were at the center of what has been called a “Reddit Revolution,” which orchestrated massive “short squeezes,” sending their share prices exponentially higher. A “short-squeeze” occurs when a heavily shorted security becomes crowded, and the short-sellers, who have borrowed the shares begin to cover (or close out) their short position in an effort to cut their losses. This move places upward pressure on the “shorted” stock pushing the share price higher. The move can be further exaggerated by margin calls and shares being called in by the broker lending the security. As the share price rises even higher, other short sellers are forced to cover, with the end result often being a security trading significantly above its intrinsic value. A short-seller’s losses are unlimited, making the practice of short-selling extremely risky. GameStop, which traded as low as $3.10 in the last 52 weeks, traded as high as $483 per share at the height of the frenzy. At the peak, GameStop had a market capitalization of approximately $34 billion despite a deteriorating business model and mounting losses. There was also talk that the squeeze was orchestrated to send a message with regard to the inequalities of capitalism to the “establishment,” or “suits” (in the words of the Robinhood and Reddit crowds). Elon Musk and Chamath Palihapitiya even tweeted about GameStop, throwing additional gasoline on the fire. While we are strongly in favor of democratizing the markets, it is our belief that when the last chapter is written, this will end badly for most of the participants. Hopefully, this will not sour a new generation of investors towards the equity markets and our capitalist economy. While Robinhood brought free trading and “gamification” to a new group of investors—perhaps they failed to get the message across that investing is not a game and one should not confuse speculating with investing.

Charlie Munger, Vice Chairman of Berkshire Hathaway, in an interview with the Wall Street Journal (2/25/2021) stated, “It’s really just wild speculation, like casino gambling or racetrack betting. There is a long history of destructive capitalism, these trading orgies whooped up by the people who profit from them.” We continue to approach investing in common stocks as essentially owning a fractional ownership of a company rather than a piece of paper. As Warren Buffett stated, “Investing is most intelligent when it is most businesslike.”

First Quarter Portfolio Activity

The dramatic market “melt-up” continued in the first quarter as investors are expecting the “reopening” of the economy to drive huge rebounds in GDP and the more cyclical areas of the economy. As a value-oriented investor, there are prices where our discipline dictates that we begin to trim positions that have become oversized and/or approached our short-term price objective. With that in mind, we trimmed our positions in a number of stocks that had exhibited what we consider strong performance over the past year(s). Some of the names that were pared back included: Twitter, Walt Disney, Sony and Qualcomm. Dominion Energy was eliminated from the portfolio late in the first quarter as we believe the headwinds of higher interest rates and bondlike characteristics of the sector will likely limit any upside going forward.

Two names were added to the portfolio during the quarter, Vontier Corporation (VNT) and Fiserv (FISV). Vontier is a Raleigh, NC- based company that was recently spun-out of Fortive Corporation. The company is an industrial technology company, with offerings in retail fueling, auto repair, telematics and smart cities. VNT is largely a capital allocation story, with steady cash flows likely directed towards M&A in adjacent transportation markets. Vontier trades at a significant discount to its industrial peer group and we believe the shares are undervalued. Fiserv, which provides payment and financial services technology worldwide, was also purchased in the first quarter. FISV should benefit from cost synergies related to the acquisition of First Data over the next few years. Fiserv subsidiary, Clover, is showing strong growth in payment volumes and could be an underappreciated asset. FISV currently trades at discount the S&P 500 and we believe it should exhibit significant free cash flow generation over the next several years.

Contributors and Detractors for Classic Value

Our thoughts on positions that had the most positive impact on the strategy for the period ending 3/31/2021

Invesco Ltd, (IVZ) (+45.6%)
For the second consecutive quarter, Invesco shares were a top contributor to the Classic Value strategy performance. Invesco revenues and earnings for the most recent quarter came in above estimates and fund inflows were just under $10 billion for the fourth quarter. Total assets under management ended the fourth quarter at $1.35 trillion a record. Activist investor Nelson Peltz continues to be involved and owns approximately 10% of the shares. IVZ shares, which trade at approximately 10 times earnings continue to look attractive.

Mosaic (MOS) (+37.6%)
Mosaic’s quarterly revenues and earnings beat consensus estimates handily in the past quarter as the company saw improving fertilizer markets and a tightening supply-demand balance in both potash and phosphates. The earning’s strength is expected to continue, and the consensus estimate for 2021 is $2.61 per share. In our opinion, shares continue to appear attractive trading at approximately 12 times estimates.

MetLife (MET) (+30.5%)
MetLife’s quarterly revenues and earnings surpassed estimates for the fourth quarter. MET shares trade at under 10 times estimated earnings and a discount to book value. MET is divesting the auto and home business units, which should strengthen the balance sheet. The life insurance sector should benefit from the trend of higher interest rates and the steepening of the yield curve. We believe MET shares, which yield 3%, remain an attractive total return vehicle.

Intel (INTC) (+29.2%)
In a change of fortune, Intel shares went from one of the largest detractors last quarter to one of the largest positive contributors this quarter. As we discussed last quarter, Dan Loeb of Third Point Capital has become involved, and investors have reacted favorably to the news that Pat Gelsinger has been named as the new CEO. INTC also recently announced plans to invest $20 billion in new foundry business, which is a major strategic change for the company. Intel shares are inexpensive relative to the semiconductor group at 13 times trailing earnings. The shares yield over 2%.

International Flavors and Fragrances (IFF) (+29.0%)
International Flavors was added to the Classic Value strategy in the fourth quarter of 2020. The shares had been pressured in advance of the closing of the acquisition of Dupont’s Nutrition and Biosciences unit which closed in February 2021. The transaction is expected to strengthen IFF’s position in a number of consumer areas including food and beverage, personal care, and health and wellness. Cost synergies are also expected over the next few years. IFF shares have a dividend yield of 2.2%.

Our thoughts on portfolio positions that had negative or the least positive impact on the strategy for the period ending 3/31/2021

Qualcomm (QCOM) (-11.8%)
Qualcomm shares have been under pressure in the first quarter of 2021 despite earnings that surged 119% in the first quarter. While revenues missed estimates slightly, we believe the share price weakness is largely related to overall weakness in the tech sector in early 2021. We believe QCOM remains well positioned to benefit from strong 5G demand. Qualcomm shares currently trade at 19 times forward estimates and yield 1.9%.

Vontier (VNT) (-9.8%)
Vontier shares were added in the first quarter. Share price weakness is likely due to the recent secondary offering of some $1.6 billion in common stock which was anticipated in conjunction for the spinout from Fortive. (See above for more on VNT).

Apple (AAPL) (-7.8%)
Apple shares were weak as investors have rotated from mega-cap tech issues over the last two quarters. AAPL shares are up just under 92% over the past twelve months and currently AAPL is the largest holding in the S&P 500 Index. We believe Apple remains well positioned for growth with the transition to 5G phones and increased services revenue growth.

Terminix (TMX) (-6.5%)
During the second half of 2020, Terminix transitioned itself into a pure play pest control business by selling the ServiceMaster Brands franchise. Proceeds from the sale will be used for debt reduction and to fund the acquisition of complementary businesses. We believe the focus on the pest control segment is the correct strategy as it has historically been a free cash flow generator.

Novartis (NVS) (-5.9%)
Novartis shares have languished due to weakness in the pharma sector and disappointing fourth quarter results. Fourth quarter results were impacted by disruptions due to the COVID-19 pandemic. Shares should benefit as the company has excellent prospects for top and bottom-line growth as more normal conditions return for the health care industry. NVS shares yield 3.9%, which we believe should provide downside protection.

Commentary & Thoughts

Our International strategy had a so-so quarter. The rotation from growth to value was not limited to the U.S., as several of our more growth-oriented businesses had a tough quarter stock-wise. U.S.—China relations continue to evolve now with Biden at the helm. Our Chinese e-commerce businesses are definitely in the growth factor and therefore their stocks were impacted by PE compression/higher interest rates just like the FAANG stocks in the U.S.

Brexit has come and gone and has and will impact the U.K. in a negative way, yet there are opportunities due to Brexit. One of our only two U.K. investments, Ferguson PLC, actually derives 80% of its revenue outside the U.K. Europe, (with the exception of the U.K.) looks very attractive to us as the pandemic has brought an unprecedented level of Central Bank action in an attempt to limit the economic impact to businesses and citizens in Europe. The European Union has finally begun to truly work together. Unfortunately, it took a global pandemic to force their hand, but they collectively put a comprehensive stimulus program together and when finally deployed, we believe it will be the rising tide that lifts a lot of boats.

We continue to use a non-consensus approach to identify undervalued, out of favor, franchise quality companies that appear misunderstood and mis-priced. We have the largest “on-deck circle” of international investee candidates in our history. They range from eSports gambling to Japanese tire manufacturers and air filtration to construction cement.

We have slowly started to nibble at a few of these businesses as diligence has wrapped up, but we await better entry points and hence, less risk. An example of this relates to ICON, which we added to meaningfully this quarter on a 14% pullback. ICON is a Contract Research Organization (CRO), which engages in providing outsourced development services to the pharmaceutical industry. These services mostly relate to clinical trials that support the various stages of the clinical development process for new drugs. We hope to have opportunities to buy more shares in our “on-deck circle” of investees in the upcoming quarters.

Contributors and Detractors for International Strategy

Our thoughts on positions that had the most positive impact on the strategy for the period ending 3/31/2021

Siemens AG (SIEGY) (+14.63%)
Siemens is a well-known large German-based technology company. The shares were boosted this quarter by robust sales and earnings growth as well as increased awareness of its smart infrastructure segment, which supplies and intelligently converts energy systems and building technologies.

DBS Group Holdings (DBSDY) (+13.65%)
Development Bank of Singapore (DBS) is one of the highest-rated banking groups in Asia. Singapore is the only AAA-rated (by Moody’s) city in the Asian region and DBS has continued this quarter with its proven track record of growing earnings. The stock was boosted by the higher interest rates as were our bank investments in the U.S.

Ten Cent Holdings LTD (TCEHY) (+11.00%)
Ten Cent is a Chinese multinational technology conglomerate. China is the world’s only economy that grew during the virus. Ten Cent’s business of online gaming and WeChat messaging business continue to perform well. These platforms continue to drive 25% revenue growth and 20% growth in operating profit. Geopolitical risks between China and U.S. will persist, but we are comfortable with Ten Cent.

DNB ASA (DNHBY) (+9.10%)
Development Bank of Norway’s (DNB) shares performed well, like many banks on reflation prospects and higher interest rates. DNB is Norway’s largest financial services company, and we are comforted by DNB’s historical return on equity of 12% and its 17% common equity Tier 1 capital ratio, not to mention its current 4% dividend.

Linde PLC (LIN) (+6.31%)
Linde is an industrial gases and engineering company. Demand for nitrogen, argon, helium, and other gases have been weak in Europe due to the pandemic. We are comforted by the company’s ability to grow earnings at 12%, operating cash flow at 21%, and increased return on capital to 13%. We feel good about the rebound in demand for Linde as Europe recovers from the pandemic and its economies open up.

Our thoughts on portfolio positions that had negative or the least positive impact on the strategy for the period ending 3/31/2021

New Oriental Education (TCEHY) (-24.65%)
New Oriental is the largest provider of private educational services in China. The shares were very weak this quarter on the risk that China may ban the use of online education for students below seven years of age. The government is inspecting and recertifying after-school tutoring institutions. We are watching this very closely for further development.

Heineken NV (HEINY) (-7.59%)
We believe Heineken is one of the greatest global brands. Unfortunately, beer volumes have been impacted by the pandemic. We feel very good about our HEINY investment as the company outperforms the category across its key markets. As economies continue to open up, travel resumes, warmer weather comes, we are confident in Heineken’s stock long term.

Roche Holding AG (RHHBY) (-7.48%)
Roche, the Swiss healthcare giant, continues to perform well from our perspective. They are one of the world’s leaders in both biotech and diagnostics. Cancer biologics are driving solid revenue growth. Many of the large pharma stocks have come under some pressure related to the new Democratic administration in the U.S. and potential healthcare reform risks. We are undeterred and remain very comfortable with our position in a leader in oncology therapies.

Safran SA (SAFRY) (-6.65%)
Safran continues to be a key player in aircraft jet engines. Obviously, air travel is not back to normal, but we remain comfortable with our investment in Safran. Today’s newer aircraft engines are five times more fuel-efficient and it helps that the Boeing 737 MAX is back in service. We expect the shares to perform better as air travel recovers.

Nestle SA (NSRGY) (-5.34)
Nestle has risen to the challenge of the global pandemic. The company is now in its third consecutive year of improved organic sales growth and margins. The company’s pet care business is strong as pet ownership continues to grow and the coffee and plant-based food channel remains strong. Nestle should benefit from an opening up of the world post-pandemic.

Just when you thought you came close to figuring out and wrestling with the latest speculative craze…we now have “NFTs or nonfungible tokens.” A digital artist from South Carolina, known as Beeple, recently sold at Christie’s a $69 million indiscriminate collage of software created pictures of cartoon monsters and unrealistic, tasteless images. “Everydays – The First 5000 Days” was purchased with a cryptocurrency by someone or something who goes by Metakovan. While this unique string of digital characters logged on a blockchain might be considered art, time will tell if this is a new frontier in the art world or the pinnacle of this latest speculative phase in this market cycle.

Markets, whether for stocks or art, have minds of their own and they often fluctuate by changes in investor psychology, not by changes in fundamentals. Investors and speculators’ psyches are very ebullient currently as evidenced by the online day traders and $69 million Beeple art.

Many on Wall Street use an old adage related to stages of bull markets:

• Stage one is when a few forward-looking people begin to believe things will get better
• Stage two is when most investors realize improvement is actually underway
• Stage three is when everyone concludes everything will get better forever

It feels like stage three to us now. Giddiness is setting in. These are too many examples to note. Everybody wants in and wants to be in everything. Many may be ignoring the cyclical nature of all markets and are concluding that these easy gains will go on forever. History has shown time and time again, in the late stages of great bull markets, people become willing to pay prices for things (stocks, real estate, art) that assume the good times will go on forever.

But they typically can’t, and they usually won’t. Markets of all kinds can’t move in one direction forever. You have to appreciate the cyclical nature of markets and understand that many markets resemble the movement of a pendulum. The ball swinging spends little time at the center of its arc. Instead, it is always swinging outward to the limits of its arc, only to inevitably swing back towards the center and then onward to its other peak. We can’t predict timing changes in cycles or tell you where the pendulum ball is. We didn’t predict the crash of 1987, the dot.com 2000 meltdown, the great financial crisis of 2008 or our recent virus pandemic. But in 1987, 2000 and 2008, it wasn’t impossible to get a sense that the market was euphoric and most likely in stage three. Investor behavior then, like today, was unquestionably “giddy.”

We don’t ever know we are getting close to the end of a cycle. We have no crystal ball. We may never know when the tide will turn, but it feels awfully high now. All we can control is the way in which we manage your hard-earned assets. We will continue, as always, to manage your money as if it is our own, with a margin of safety and a keen awareness of what stage we feel like we are in, and what risk and reward opportunities lie ahead.

Now one year after the onset of the pandemic, we remain ever more humbled and appreciative of our partnership with you. We are grateful for your willingness to compensate us for doing something we love to do and is so important to us all. Our entire Live Oak Private Wealth team looks forward to our continued shared success together

With warmest regards,

 

Disclosures

1. Past performance is no guarantee of future results and future performance may be higher or lower than the performance shown. The performance results for each equity sleeve are calculated for us by Orion Services and does not reflect investment management fees, custody and other costs or taxes. All of which would be incurred by an investor in any account managed by Live Oak Private Wealth.
2. The performance attribution represented is a simple point-to-point price percentage change for the five best and five worst portfolio positions for the third quarter ending September 30, 2020 Each equity sleeve does not and is not intended to indicate past or future performance for any account or investment strategy managed by Live Oak Private Wealth. Additionally, there is no guarantee that all portfolios will own any or all of the companies mentioned.
3. There can be no assurance that our portfolio management or any account managed by our investment managers will achieve a targeted rate of return or volatility or any other specified parameters. There is no guarantee against loss resulting from an investment.
4. Investment objectives, returns, and volatility are used for measurements and/or comparison purposes only and are only a guideline for prospective investors to evaluate our investment strategy and the accompanying risk/reward ratios.
5. Comparison to any index is for illustrative purposes only. Certain information, including index and benchmark information, has been provided by third-party sources, and although believed to be reliable, has not been independently verified and its accuracy cannot be guaranteed.
6. The information contained here is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other important information contained in Part 2A or 2B of Form ADV. This presentation is for informational purposes only and does not constitute an offer to sell or as a solicitation.
7. Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor. Registration does not imply a certain level of skill or training.
8. Opinion and thoughts expressed are those of Bill Coleman and Frank Jolley and not Live Oak Bank.
9. Not all portfolios will necessarily own all companies mentioned, due to factors such as legacy positions, capital gain constraints, sector concentration, time, and other considerations.